ERISA Liability for CPAs

A little caution goes a long way.
BY MICHAEL J. COLLINS

  

EXECUTIVE SUMMARY
  • CPAs WHO PROVIDE PROFESSIONAL SERVICES TO employee benefit plans face potential liability exposure under ERISA. A June U.S. Supreme Court case made it clear that CPAs and other service providers are at risk even though in many instances their actions may seem innocuous.
  • ERISA IMPOSES CERTAIN DUTIES ON PLAN FIDUCIARIES, such as acting exclusively in the interest of plan beneficiaries, acting prudently and diversifying plan investments. A CPA who provides investment advice to a plan or serves as the plan administrator may be a fiduciary for ERISA purposes. CPAs generally are fiduciaries for their own pension plans.
  • ERISA PROHIBITS A FIDUCIARY FROM ENGAGING in certain transactions with a party in interest. A CPA who audits a plan’s assets is a party in interest. The remedies for prohibited transactions are harsh. The transaction must be undone and the plan put in the position it would have been in had the transaction not taken place. A qualified plan pays a 15% excise tax every year until it corrects the transaction.
  • IN HARRIS TRUST V. SALOMON BROTHERS, the U.S. Supreme Court made it clear that a nonfiduciary party in interest (such as a CPA) can be held liable under ERISA for participating in a prohibited transaction. Under some circumstances, even a CPA’s fees could violate the prohibited transaction rules.
  • THE FIRST STEP TO AVOIDING LIABILITY IS TO REALIZE there is always a risk in any dealings with an ERISA-covered plan. CPAs should avoid transactions with a potential conflict between their own interests and those of plan participants.
MICHAEL J. COLLINS is an attorney with Gibson, Dunn & Crutcher, LLP, in Washington D.C. His e-mail address is mcollins@gdclaw.com .

he strict legal requirements of ERISA can rise up to bite an unsuspecting CPA at any time. A June 2000 U.S. Supreme Court case, Harris Trust v. Salomon Brothers, makes clear that CPAs and other service providers may face exposure under ERISA for various transactions with employee benefit plans, even though, in many cases, their actions seem innocuous. A transaction that appears to benefit a plan may, for example, be prohibited under ERISA.

CPAs provide a variety of professional services to pension and other employee benefit plans—auditing the plans, advising clients on applicable tax rules and even providing investment advice. In some cases, CPAs administer the plans for smaller clients, collecting contributions, choosing how to invest plan assets, processing participant distribution requests and making all required IRS filings. Providing such services requires a CPA to be familiar with the often complex requirements of ERISA. This article outlines the potential liability exposure of CPAs and other professionals who provide services to ERISA plans, and discusses ways to reduce it.

ERISA’s FIDUCIARY RULES

After it went through nearly a decade of development, President Ford signed ERISA into law on Labor Day in 1974. A key to its passage was the belief that employers and other parties with control of pension plan funds used them for their own benefit rather than for that of employees. For example, employers used pension plan funds to purchase their own stock at inflated prices or paid service providers excessive fees.

In enacting ERISA, Congress sought to end these abuses in two ways. First, section 404 of ERISA imposes on fiduciaries the duties of

  • Acting exclusively in the interests of plan participants and beneficiaries.

  • Acting prudently (under a “reasonable person” standard).

  • Diversifying plan investments.

ERISA broadly defines the term “fiduciary” to include people with discretionary authority or control over plan assets or plan administration and people who render investment advice for a fee. A CPA who provides investment advice to a plan or serves as the plan administrator may be a fiduciary for ERISA purposes. In addition, CPAs usually are fiduciaries for their own pension plans.

Second, section 406 of ERISA forbids a fiduciary from causing a plan to engage in certain “prohibited transactions” with a “party in interest.” Prohibited transactions are per se violations of ERISA, regardless of whether they otherwise satisfy the fiduciary duties of section 404, or even if they are favorable for the plan. ERISA defines party in interest to generally include, among others, employers that sponsor plans and people who have significant dealings with ERISA-covered plans, including anyone providing services to a plan. For example, a CPA who audits a plan’s assets is a party in interest. In addition, a CPA usually is a party in interest to a plan sponsored by his or her firm, because the firm is the employer maintaining the plan.

Prohibited transactions include the following actions between an ERISA-covered plan and a party in interest:

  • Sale or exchange of property.

  • Lending money or any extension of credit. (For example, a CPA who gives a promissory note to a plan sponsored by his or her firm in lieu of cash contributions would violate this rule.)

  • Furnishing goods or services to the plan for an unreasonable consideration.

  • Transferring plan assets to a party in interest.

  • Investing plan assets in the plan sponsor’s stock, subject to certain exceptions.

The remedy for a prohibited transaction may be harsh. Typically, the transaction must be “undone” and the plan returned to the position it would have been in had the prohibited transaction not occurred. The Department of Labor or a plan participant may sue any fiduciary or party in interest who engages in a prohibited transaction. In addition, if a tax-qualified retirement plan enters into the transaction, a 15% annual excise tax applies for every year until the plan corrects the transaction, with an additional 100% penalty if it does not correct the transaction following an IRS assessment of the 15% excise tax.

THE SUPREME COURT EXPANDS ERISA

Before the U.S. Supreme Court decision in Salomon Brothers, it was an open question whether a nonfiduciary party in interest could be held liable under ERISA for “participating” in a prohibited transaction. The Court made clear that ERISA imposes this liability, putting all plan service providers at risk.

The facts of the case are as follows. In the late 1980s, Salomon Brothers arranged financing for two motel chains to acquire motel properties throughout the United States. In four separate transactions, the chains sold mortgage notes secured by the acquired properties to Salomon, which in turn sold the notes to institutional investors. In exchange for its services, Salomon received “participation interests” in the properties’ net cash flow, plus a specified percentage of any appreciation in their value.

At the same time, Salomon provided broker-dealer services to the Ameritech Pension Trust, which held assets for various tax-qualified pension plans sponsored by Ameritech Corp. Salomon received several hundred thousand dollars per year in commissions and other compensation for its services to the trust. In this capacity, Salomon was a party in interest, but not a fiduciary.

In transactions unrelated to Salomon’s broker-dealer services, the trust agreed—following extensive negotiations—to purchase nearly all of Salomon’s participation interests in the motel properties for approximately $21 million. During the recession in the early 1990s, the nationwide market for hotel/motel properties experienced a significant decline and the participation interests became almost worthless.

In 1992, Harris Trust and Savings Bank, the new trustee of the Ameritech Pension Trust, sued Salomon on the trust’s behalf seeking to hold Salomon liable for the trust’s losses on the participation interests. Among other allegations, Harris Trust said that Salomon should be forced to reimburse the pension trust because Salomon’s sale of the participation interests was a prohibited transaction under section 406 of ERISA. It also claimed that Salomon failed to disclose in a timely manner information relating to the riskiness, poor performance and low value of the participation interests.

The U.S. Supreme Court decided Harris Trust could sue Salomon Brothers on the plan’s behalf for Salomon’s participation in a transaction prohibited by section 406. Although the Court was not presented with the issue, its reasoning strongly implied that it would also impose liability on nonfiduciaries who participated in a fiduciary’s breach of its duties under section 404 of ERISA. Thus, any CPA firm or other service provider that participated in a fiduciary’s breach or a prohibited transaction may be subject to liability under ERISA.

WHO’S AT RISK?

Fiduciaries are the parties most clearly at risk under ERISA. A plan participant or the Department of Labor can sue a CPA/fiduciary if he or she fails to act in the exclusive interest of participants, to act prudently, or, if the CPA is in charge of plan investments, to diversify those investments.

For example, consider a CPA who serves as administrator of a client’s pension plan and is in charge of selecting plan investments. Following a hot tip from a friend, but without doing much additional research, the CPA invests 50% of plan funds in the stock of a single publicly traded company. That company later announces it is entering bankruptcy proceedings, and the plan sells the stock at a large loss. In addition to an extremely upset client, the CPA now faces the possibility of having to pay to the plan, out of his or her own pocket, the amount lost, plus interest.

Even if a CPA is not a plan fiduciary, Salomon Brothers illustrates the risks related to any plan to which he or she provides services. Some actions present obvious risks of ERISA liability. For example, if a CPA provides investment advice to an ERISA pension plan and recommends a limited partnership or other business the CPA has an interest in, he or she may have engaged in a prohibited transaction. This can be quite costly—in addition to the 15% annual excise tax and possible claims under state law, the CPA effectively would be the guarantor of the investment until the transaction is undone.

As another example, consider the case of Framingham Union Hospital v. Travelers Insurance Co., which a Massachusetts federal court decided in 1989. The employer and trustees of an ERISA plan sued an accountant who helped prepare a proposal to fund benefits under the plan. They alleged the proposal violated ERISA requirements and the accountant had engaged in misrepresentations and omissions in persuading the employer’s board of directors to adopt it. The court said that the accountant could be held liable for actively assisting in the formulation and presentation of the proposal.

At a more basic level, even a CPA’s fees may violate ERISA’s prohibited transaction rules if the plan pays the fees. Because a CPA who provides services to a plan is an ERISA party in interest, the fees are considered a transfer of property from the plan to a party in interest. In this context, ERISA allows only fees that are “reasonable” in amount and paid for services that are “necessary for the establishment or operation of the plan.” If the fees do not satisfy either of the requirements, the CPA may be forced to return them to the plan and could also be subject to the IRS-imposed excise tax. Consider a CPA who provides services to a client that is in difficult financial straits but that maintains an overfunded pension plan. If the CPA agrees to accept any fees from the plan for services performed for the client, both the client and the CPA have engaged in a prohibited transaction.

Learn More About ERISA

CPAs who understand the ins and outs of ERISA may be less apt to make costly missteps.

www.dol.gov/dol/asp/public/programs/handbook/erisa.htm. A small business handbook on employee benefit plans, including ERISA, from the Department of Labor.

www.dol.gov/dol/pwba. A variety of helpful publications on pension rights, ERISA and related subjects from the Pension and Welfare Benefits Administration.

www.pbgc.gov/smbus.htp .A guide for small businesses from the Pension Benefit Guaranty Corporation.

wwwsecure.law.cornell.edu/topics/pensions.html . An overview of pension law from the Legal Information Institute.

www.401khelpcenter.com . A resource site for plan sponsors, small business owners and plan participants.

STRATEGIES FOR AVOIDING LIABILITY

How can a CPA avoid potentially devastating liability under ERISA? The first step is to realize that there is always a risk of liability for any dealings with an ERISA-covered plan. Avoid any transaction that has a potential conflict between the CPA’s interests and plan participants. The same applies to any transaction where there is a potential conflict between the interests of the client and plan participants. The CPA should withdraw from any engagement in which he or she could be deemed to participate in a transaction involving such a conflict.

A key question is whether the CPA is a plan fiduciary. For the CPA’s own plan, the likely answer is “yes.” For a client’s plan, the CPA is a fiduciary if he or she has any discretionary authority over the plan, or if he or she provides investment advice for a fee. In less obvious cases, it may make sense to consult an attorney who specializes in ERISA. Fiduciaries are more at risk than nonfiduciaries because of the extensive duties that ERISA places on them. They are required to take active steps (to act prudently), while nonfiduciaries generally need only avoid certain types of transactions.

A CPA/fiduciary should be aware of the potential risks of acting in this capacity. The exclusive benefit, prudence and diversification requirements often are not easy to apply in the real world. The CPA also should strongly consider obtaining fiduciary insurance. Although such insurance usually does not cover intentional breaches of fiduciary duty, it generally will cover negligent breaches (see the exhibit below for more on the risks fiduciary insurance can protect against).

A CPA who provides services to the plan is generally a party in interest and should be extremely wary of assisting a client with any transaction involving the plan, unless expert legal help is sought. The prohibited transaction rules are complicated and counterintuitive in many respects. An ERISA specialist may be able to quickly determine whether the transaction involves ERISA rules and suggest alternatives that will substantially reduce the risk of liability to the client and to the CPA.

Any fees paid to the CPA from plan assets must be reasonable. Obviously, this is a somewhat amorphous standard. As a general rule, if the hourly rate the CPA charges to the plan is the same as the rate for services he or she performs for the client generally, this requirement should be satisfied. In addition, fees paid from the plan must be for services necessary for the operation or establishment of the plan, not for services performed for the client itself. For example, a CPA should never accept fees from the plan for tax consulting services he or she performs for the client.

TRAPS FOR THE UNWARY

Because of the many pitfalls, any CPA who advises an ERISA plan should be prepared to confront the risk of potential liability. Given the complexity of ERISA’s rules, legal advice is often needed to help CPAs avoid potential fiduciary breaches and prohibited transactions. With the U.S. Supreme Court’s apparent expansion of ERISA’s reach, proper planning today can reduce sleepless nights tomorrow. It can also ensure that a CPA does not expose his or her practice to unnecessary legal liability while performing day-to-day tasks.

Fiduciary Liability Loss Scenarios
When an employee’s nest egg is threatened, there’s always a chance he or she might sue. With the future of Social Security benefits in doubt, today’s employees don’t feel as secure about the safety of their retirement funds as in the past. And with companies shifting to profit-sharing plans that don’t guarantee a specific retirement income as well as most employees changing companies every few years, it’s no wonder workers are disappointed when their retirement income is not what they expected.

Individual fiduciaries, the sponsor organization and the plan can all be held liable under ERISA. The fiduciary liability loss scenarios described below help shed some light for CPAs on who might be at risk. Fiduciary liability insurance is one way to protect against the financial consequences of these risks.

Scenarios

Failure to adequately inform participants. The Department of Labor sued the individual plan administrator, the 401(k) plan and the sponsor organization alleging they failed to inform employees when they switched guaranteed income contract (GIC) companies and misled participants by continuing to use the old company’s enrollment forms.

Indemnity: $1 million    

ESOP class action. A financially troubled employer negotiated wage reductions with employees in exchange for an ESOP. When the ESOP was finally established, the effective date excluded former employees and those promoted to management since the wage negotiations. Excluded employees initiated a class action and sued individual plan fiduciaries, the plan and the sponsor to recover forfeited wages and to gain the ability to participate in the plan.

    Defense costs: $535,000

Miscalculation of benefits. About 10,000 current and former employees initiated a class action and sued the individual plan administrator and the sponsor organization for miscalculating pension benefits. The sponsor organization settled with employees for approximately $70 million in benefits and administrative costs.

Indemnity: $1,160,000   Defense costs: $1,850,000

Error in plan administration. A retired employee sued the plan administrator and the pension plan alleging an administration error and a miscalculation of plan benefits. The employee had announced plans to retire and requested in writing a pension calculation. The plan administrator took more than 45 days to value the plan assets. During this time there was a substantial drop in the stock market that adversely affected the value of the employee’s retirement funds.

Indemnity: $80,000    

Miscalculation of benefits. Current and retired female employees initiated a class action and sued the plan administrator, the plan and the sponsor alleging that they had failed to account for maternity leave when calculating time in service for pension calculations.

Indemnity: $1,875,000   Defense costs: $680,000

Error in administration of benefits. A plan participant’s spouse sued the plan administrator and the sponsor organization for spousal pension rights. The spouse alleged the plan participant had forged the signature on the spousal release form, which the plan administrator notarized, releasing the spouse’s retirement funds to the participant.

Indemnity: $400,000    

Violated terms of the trust agreement. Union and non-union employees who participated in a 401(k) plan class action sued the investment committee, the plan administrator, the plan and the sponsor alleging the $120 million investment in an insurance company’s GICs was imprudent because of the company’s extensive junk bond holdings. It took three years to settle the case.

Indemnity: $13 million   Defense costs: $770,000

Source: Chubb Insurance Co., www.chubb.com/businesses.

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